European Credit Downgraded: What's Next?

This is WEEKEND EDITION from NPR News. I'm Scott Simon. Many Europeans woke up again this morning with a debt-induced hangover. Late yesterday, the U.S. credit rating agency, Standard & Poor's, downgraded nine European countries - large ones: France Italy and Spain - smaller ones, too: Slovakia and Slovenia. But Germany retained its AAA rating. S&P suggested that Europe's single-minded focus on austerity to solve its sovereign debt problem is just not working. The ratings agency also said policy initiatives taken by European leaders, quote, "maybe insufficient to fully address ongoing systemic stresses in the Eurozone." Here's S&P managing director of sovereign ratings, John Chambers, speaking to Bloomberg Television.

JOHN CHAMBERS: We see mounting systemic stress throughout the Eurozone. We see it not as much a fiscal crisis as a problem of growing disparities in competiveness. We see it more of an external issue than a fiscal issue.

SIMON: Coming up, we'll hear how French officials are reacting to the downgrade and the challenge presents for President Nicholas Sarkozy, who's expected to run for reelection this spring. First, NPR's John Ydstie joins us. John, thanks for being with us.

JOHN YDSTIE, BYLINE: Hi, Scott.

SIMON: John, this downgrade was kind of signaled in December. How big is this decision now that it's actually been made?

YDSTIE: Well, you'll get some differing opinions on how big a deal this is. I don't think you're going to have a big effect in the financial markets the way you did when the U.S. lost its AAA credit rating back in August. Yesterday, it was quite clear all day that this was going to happen and stock markets fell less than a percentage point in both Europe and the United States. And interest rates for sovereign debt didn't change significantly either. After all, France, which lost its cherished AAA rating, was already paying borrowing costs more in line its new rating AA-plus status - it just doesn't have that ring of AAA, does it? And that was the case with Italy, too, which had its rating downgraded two notches. It was already paying costs, borrowing costs, in line with that as well.

SIMON: So, does that mean the rating agencies just aren't pertinent anymore?

YDSTIE: Well, I think a lot of people think that S&P was sort of confirming what the market has already said, that it's a bit behind the curve rather than really moving the markets. And what is interesting is that S&P provided some sort of political commentary on Europe's strategy of austerity to try to solve its sovereign debt problem, though it will be, I think, surprising if that moves the Europeans to change their strategy at all.

SIMON: You suggest there might be little effect from this decision?

YDSTIE: Well, because of the special role the regulators, governments and investors have conferred on the credit rating agencies, there will be some real effects. For instance, it could raise borrowing costs for the Europe's crisis rescue fund, because one of the big economies guaranteeing the fund, France, now no longer has AAA status. And on a more micro-level, let's say you're a business that borrowed money and your contract with your lender says that it has to be backed by bonds that are AAA. Well, if you're using French bonds as collateral, you'll have to find something else. Mohamed El-Erian, who heads the big bond fund PIMCO, takes an even broader view of this. He points out this is one more AAA-rated country falling by the wayside, along with the U.S. and Japan.

MOHAMED EL-ERIAN: How does the global system operate now that Europe at its core and the U.S., also at the core of the global system, no longer enjoy unquestionable AAA status? That is a fundamental question. It's consequential and I think it's going to play out over a number of years. But it speaks to transformations and re-alignments.

SIMON: In what directions?

YDSTIE: Now, El-Erian says he doesn't know for sure, but certainly it suggests more economic clout moving toward China and to some of the other strong emerging-market countries.

SIMON: What about realignment within Europe itself, now that France and Italy have being downgraded but Germany has retained that AAA rating?

YDSTIE: That's certainly a possibility. First of all, it could complicate Nicolas Sarkozy's bid for a second term as France's president. But there could also be broader effects in Europe too. As you said, Germany retains its AAA rating and France is diminished. Now remember, throughout the development of the European Union and the euro currency, France and Germany have been pretty much equal partners. But as one European analyst told me yesterday, this action makes France less like Germany and more like Italy. So it could cement Germany's position in the driver's seat in Europe. France's finance minister tried to put the best face on it yesterday. He said this is not a catastrophe. It's an excellent rating - that is the new AA-plus rating - but he acknowledged it's not good news.